Thursday, May 5, 2016

Why the Blockchain should be familiar to you

I'm freshly returned from Consensus 2016: Making Blockchain Real where I participated in a panel on "Digital Cash for Central Bankers." Michael Casey did a stellar job in crafting the session. It was fun and informative to have Simon Johnson and John Schindler as co-panelists. As we didn't get booed off the stage, I think maybe the audience enjoyed what we had to say as well. (I left the session with almost a kilogram of business cards--odd that paper is still so widely used in this capacity. By the way, some of what I had to say can be found in my blog post here.)

Today's post is more about marketing the idea of blockchain. The word sounds intimidating to many people. That's probably because attempts to explain it often make use of a highly technical trade language that few people understand. My goal here is to think of ways to communicate the idea of blockchain in a manner that will make people feel like the concept is familiar to them. Indeed, I believe that the broad conceptual idea of blockchain should be familiar to us all.

It will take time for the idea of decentralized trust through computation to become a part of mainstream consciousness, and until then, the idea creates cognitive dissonance for those accustomed to centralized trust systems. With thousands of years of practical use, centralized systems of trust are accepted unconditionally and without much thought as the only model of trust.

It's an excellent article and I highly recommend you read it. What I want to do here is push back a little on the notion that decentralized trust systems should necessarily create cognitive dissonance. In particular, I should like to point out that we've had tens of thousands of years of experience with decentralized trust systems. Alright, so let's get started.

Consider the following scenario. You are attending a cocktail party with dozens of people present and you are asked by your hostess to deliver a short speech. Now suppose you utter something outrageous, e.g., "I think the Fed should buy the existing stock of bitcoin and store it as a foreign currency reserve!" The audience will stare at you, mouths agape (especially if you're a central banker, or a renowned Bitcoin enthusiast). You wake up the next day and regret your rash public remark. You wish you could take back what you said, but how? The only way this could be done is if you could somehow persuade the group to forget what you said. But just think about how difficult it would be to do that. Especially if the number of people in attendance was large.

What has just been demonstrated (I hope) is the power of a distributed database validated through a communal consensus algorithm. The database here is your silly statement above together with the time you made it (a timestamp). The information in this database is shared on a distributed network of brains (what you said and when you said it is imprinted forever in the memories of all who witnessed the event). The consensus algorithm here is "let's all agree to remember what was actually said (as opposed to some alternative, fabricated statement)."

A database in this form is extremely secure. It will survive intact even if some brains holding the database are destroyed. The database can be communicated to other brains (who can confirm the validity of the statement by seeing how it squares with the memories of others). If one or more people tried to fabricate an alternative history, the attempt would almost surely fail (we cannot rule out the possibility entirely, however). If your remark instead lived only as an electronic recording in a central databank, the task of re-writing history would be much easier.

Now imagine living in a primitive village. Relevant elements of the database would include observations like: [1] John had his wound tended to by Bob at date t, [2] John killed a wild pig and shared it with the village at date t-1, etc. The database in this case can be organized in a sequence of time-dated blocks X(t) = {x(t), x(t-1),...}, where x(t) is the database (block) at date t, and X(t) is the "blockchain." So, the blockchain is just a communal databank recording some relevant aspects of villagers' activities. In village economies, this communal memory typically exists in a virtual state (written records are a much more modern invention).

Notice how the blockchain described above could serve a very useful economic purpose. In particular, note that the act of consumption (medical services) in [1], John is effectively using [2] as currency. At least, this is how things work in what anthropologists describe as "gift-giving societies." And if you think about it for a while, you'll notice that the same principle is at work in the various groups you interact with on a daily basis (your friends, your family, coworkers, etc.). Much, quite possibly most, economic exchange occurs via such localized trust networks.

The problem with this ancient blockchain technology is that it doesn't scale very well. There's only so much data we can fit in our brains. So as populations grew and as people started forming large communities, a new type of record-keeping system was needed. The model that came to dominate is one in which databases are collected and maintained by trusted third parties. Much effort is expended in keeping these private databases secure (not always successfully). It is often difficult for these agencies to communicate and reconcile their databases (as in when you try to send money from your bank account to your friend's foreign bank account overseas).

And so enter the "new" technology, blockchain. I hope I have convinced you what is new here is not the principle of the blockchain. The new technological developments are: [1] bigger brains (increased capacity for data storage and processing via computers); [2] better communications (the Internet); and [3] computer-based algorithms to serve as communal consensus mechanisms (e.g., proof-of-work).

These innovations will permit a revolution in the truest sense of the word: we are traveling back to where we began--but with planet earth as our village.

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PS. Please let me know if this was helpful or how it could be improved. After writing this post, I came across this short video: Blockchain for Dummies. Some of the comments are critical of it, but I thought it communicated the idea in a nice way.

27 comments:

Maybe Yap stones are an example? Everyone knows who owns what stones. It's simpler for the village to keep track of the stones than to keep track of who delivered pigs, yams, labour, and everything else.

Which economist (S. American?) said that even the dogs knew who owned which land?

The UK is still filling out its centralised Land Registry. Traditionally, ownership just meant having a record of having bought it from someone else, who bought it from....etc.

Nick, I have a severe doubt that Yap stones circulated as a common exchange medium in any meaningful sense. The Yapese likely relied on gift-giving principles; the stones were likely used for ceremonial purposes (that could have be related to certain types of exchanges).

Wasn't aware of the dog story. The UK land registry sounds like a good example. Indeed, the new technology is targeted to make that record-keeping system more efficient. http://chromaway.com/papers/A-blockchain-based-property-registry.pdf

In the US anyway, the register of deeds is kept at the county level. Anyone can search the record of transfer of ownership to determine whether the title is free and clear.

The record of transfer of title of vehicles is maintained at the state level. It's now possible to search transfer of ownership nationally using the VIN (vehicle identification number) online.

Land records are now also being digitized and made available for online search often at the state level, but the responsibility for maintenance of the records remains at the county level. This is a pretty distributed, decentralized system at least in the US, and the level of trust is very high since lawyers experienced in real estate are generally involved.

Digitization of records will mean that anyone can access the registry from anywhere at anytime instead of having to go physically to the country registrars office, or have someone do it. For transfer of title, a title search is usually implied in the process to ensure an unclouded title.

Examples like this reveal that we are already doing "blockchain" and have been for a long time. Now that is being digitized. Nothing to be concerned about was long as the system is secure. But we already trust the security of electronically processed credit cards and online banking.

I am not suggesting that it is just about digitizing records, but rather than that the records are part of a decentralized, distributed network at the community (county) level that functions at the national level as a repository of trust. While the physical records are maintained and supervised by the registrar of deeds, the trust arises from the public availability of the records and their constant use by members of the community in exchanging property on a regular basis based on confidence in property ownership. Now these records can be accessed through a network of servers containing the information from anywhere online, but that does not change the decentralized, distributed nature of the process at the community (county) level. It increases convenience while relying on local trust in an established process. Not blockchain perhaps, but a precedent wrt to community-based trust that is analogous.

Thanks for that. Definitely useful for technical incompetents like me. Just one querie: do you need BOTH of the above examples - the cocktail party AND the village? I like the village illustration best.

The answer is as follows. Neither system dominates, as is evidenced by the fact that the two have coexisted for a long time. Decentralized is probably more secure in many cases, centralized likely has lower operating costs. Technology changes the relative benefits of the two systems. But they will likely always coexist, with each serving a need for which is well suited.

Well, a blockchain in the form of Bitcoin does afford some degree of privacy, as the "accounts" correspond to something akin to a PO box (with no visible personal identity). But there are other variations, e.g., permissioned blockchains with a few trusted validators, etc.

I respect your effort, but you asked for feedback, so I have to say honestly that I did not find this useful. I'll quickly qualify that by saying that I've found nothing yet that I've read anywhere that I find particularly useful about the subject.

I know why this is the case - in my case at least.

It is obvious that block chain is making a big splash in its intersection with the possible future for banking. Banks are studying it closely - and I guess investing in it one way or another.

Because of that, there is a big intersection with the possible future for both monetary policy and banking.

What I found in the early days of these discussions is considerable conflation of the ideas of bitcoin and block chain - and how each of these separate things (although connected at points) intersect with the future of banking and the future of monetary policy. E.g. I see no evidence that bitcoin enthusiasts know much about banking or monetary policy.

What is problematic more generally is that very few interested people have a sufficient understanding of how banks actually work. I won't expand on that here, but I hope you can appreciate that academic theories or even academic descriptions of banking are not the same as real world practice of banking. These are two different things undertaken by two different groups of human beings. This is not an insult. One shouldn't expect them to be the same, whatever the insights of the academic non-practitioners, given that they don't work in banks. For example, Diamond-Dybvig provides very little practical insight as to how banks actually manage liquidity risk.

And this probably applies to how banks function according to how they organize information.

So far, I've seen nothing written about block chain that convinces me that the writer has formed a meaningful connection between how banks and monetary policy work today, and how that practice may change under block chain.

I fully expect that monetary policy and banking will be an eventual constraint on block chain evolution - not the other way around. The banks know this, which is why they're on top of it.

So I'm sorry to say that so far I see only trivial, somewhat childish play models about "the idea" of block chain.

There must be a more meaningful, pragmatic way of getting at this subject.

The reference to the blockchain for real estate is helpful. One doesn't actually acquire "title" to a parcel of real estate: she may have evidence of title as reflected in the public records (the blockchain of transfers of the parcel), but not "title" in the sense of an uncontestible piece of paper that's "title". When I first practiced law, the convention in my county was for a lawyer to issue an opinion as to title (rather than for an insurance company to insure title). The lawyer can be sued if she is wrong, but what is she has no assets (or is dead or moved away). By comparison, a title insurance company, regulated by the state, must have sufficient assets to pay claims in case it is wrong about "title". Since the convention across the country is for title insurance (rather than lawyer's opinions), buyer's of real estate believe they are obtaining "title" when in fact they aren't. My question for Bitcoin (or other private, unregulated blockchains): who stands behind the blockchain if it's wrong?

I should point out that states have adopted laws that limit how far back in time one can go in the blockchain to challenge "title", another form of government regulation that is designed to add more certainty to real estate ownership. Law professors who teach property law love complicated cases involving the blockchain, in my state going back to the Spanish land grant.

This is a terrific analogy. If you are right that this is the concept, you've nailed an intuitive and incredibly helpful description for Blockchain.

JKH raises a very good point, but its a slightly different problem. He's right once you understand the idea behind Blockchain, you do have to understand how you apply it in the real world.

Funny story:Blockchain was used on me as proof that God exists. This was 20 odd years ago when some more saintly adult than I have become still held out hope for me.Proof that God exists? Well as he told me, all the Israelites saw God hand down the commandments to Moses, you can't change the individual memory of the entire Israelite population, therefore god must exist.

Yes, the proof relies on the chain being unbroken back to the original event which was part of the argument.I always found the most persuasive evidence for God's existence (along the lines of the sly claim that evil is the root of all money) that God must exist, as man created him in his own image.

Sorry, the blockchain video made no sense to me. I don't mean mixing up left and right, which happened early and is a common mistake. In the chain each person told one person in the chain their favorite color. Then they broke the chain and mingled at random, observing the favorite color of the person they spoke to. Later it was claimed that it would be difficult for one person who changed their color preference to make that information widely known. That is true, but it is a result of mingling with a lot of people, not the result of having a chain of information. You can leave the blockchain out of the story entirely and reach the same conclusion.

That's a good point, Mike. And one that I've thought about. It's clear that histories *can* be fabricated. Just look at N. Korea. I mean, just look at what happens when a society's consensus algorithm agrees on a falsehood that is economically harmful. My view is that Darwin is likely to take care of such mechanisms, in the long run, though obviously they can still coexist in small numbers.

Great analogy to show that the concept is "old" but the implementation is new and more effective. I think as human beings we are more "conservative" because of the "unknown" variable. Once though this variable is identified, explained, and perhaps measured we as a species tend to embrace the "new" norm very fast. I think your post adds to that. Thanks

Blockchain is a distributed database that is used to maintain a continuously growing list of records, called blocks. Every block contains a timestamp and a link to previous block. A full copy of a currency's blockchain contains every transaction ever executed in the currency. By this, one can find out how much value belonged to each address at any point in history. The chains of block connected through blocks linked together.

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